EADS Explores BAE Combination in Aerospace Revamp

The front section of an Airbus A380 aircraft sits in the production area at the Airbus SAS plant in Saint-Nazaire. Photographer: Fabrice Dimier/Bloomberg

Sept. 13 (Bloomberg) -- European Aeronautic, Defence &
Space Co. and BAE Systems Plc are reviving a decade-old plan to
build an equal to Boeing Co. that would balance civil and
defense operations in an era of shrinking military budgets.

EADS stock slumped as much as 10 percent in Paris, while
BAE declined as much as 9.2 percent in London on concern that a
combined company will struggle to achieve savings and penetrate
the U.S. defense market. EADS, the parent of Airbus SAS, would
control 60 percent of the new entity, with London-based BAE
owning the rest, the companies said yesterday.

“This will be a very complex organization and there is a
risk of synergies coming only much later,” said Yan Derocles,
an analyst at Oddo Securities in Paris. “Airbus is a big growth
story and will be heavily diluted in the new company. And
there’s also the problem of significant constraints on the
defense business in the U.S.”

The new company would have a combined market value of about
$45 billion, sales nudging $100 billion and 220,000 employees,
with assets spanning civil jets, Eurofighter warplanes and
nuclear submarines. A merger would revive plans for a single
European aerospace business that were abandoned more than a
decade ago when the formation of EADS and BAE split the industry
in the region along civil and defense lines.

‘Significant Benefits’

BAE slumped as much as 33.6 pence to 330 pence, reversing
an 11 percent surge yesterday after the companies confirmed that
they are in talks. Today’s drop, which stood at 5 percent as of
8:41 a.m. in London, clipped BAE’s market value to about 11.3
billion pounds ($18.2 billion). EADS dropped as much as 2.89
euros to 25.11 euros in Paris, valuing it at 21 billion euros
($27 billion).

The deal would add Toulouse, France-based EADS’s revenue of
about 49 billion euros last year to BAE’s 17.7 billion pounds.
That compares with $68.7 billion at Chicago-based Boeing and
$46.5 billion at Bethesda, Maryland-based Lockheed Martin Corp.,
the world’s biggest defense company.

“BAE Systems and EADS believe that the potential
combination of their two businesses offers the prospect of
significant benefits for customers and shareholders,” the
companies said in a statement after markets closed.

EADS Chief Executive Officer Tom Enders, who took over in
June, has been revamping senior management positions and
switched the leader of the Cassidian defense business this
month. Enders, a German reserve army officer, previously ran the
Airbus business, which is EADS’s biggest sales contributor and
the world’s largest maker of civil aircraft ahead of Boeing.

Airbus Dependence

The companies, who cooperate on the Eurofighter warplane,
first explored scenarios for a combination in early June,
followed by the first outlines of a combination a month later in
Munich that included the 60-40 split, a person familiar with the
talks said. Besides Enders, EADS chief strategist Marwan Lahoud
has been a driving force behind a deal, said the person, who
asked to remain anonymous because the information isn’t public.

The companies didn’t say where the combined group would be
based, or who would lead it. EADS is moving its headquarters
from Paris and Munich to Toulouse in order to be on the same
location as Airbus. Besides Airbus, EADS also has helicopter,
space and defense operations.

“EADS has been seeking to reduce its dependence on Airbus
and achieve a better balance between commercial aerospace and
defense,” said Zafar Khan, an analyst at Societe Generale in
London. “A combination with BAE would certainly achieve that.”

No Threat

BAE is a supplier to Boeing on military and commercial
aircraft, including automatic flight control systems and belly-mounted guns for the V-22 Osprey, a touch-screen attendant
control panel on the 737 airliner and engine-control systems on
787 Dreamliner jets, according to Michel Merluzeau, a consultant
with G2 Solutions in Kirkland, Washington.

Boeing CEO Jim McNerney told reporters in Washington
yesterday that a combination of EADS and BAE wouldn’t “threaten
us fundamentally.”

“I have a pretty deep and abiding faith in our company’s
strength,” he said at the Council on Foreign Relations office.
“It does reflect a global consolidation that is beginning to
happen.”

A combination of EADS and BAE would be larger than Boeing’s
purchase of McDonnell Douglas in 1997 that was valued at $16.3
billion. That deal brought together two civil aviation
manufacturers, two years after Lockheed’s defense-focused
combination with Martin Marietta Corp.

U.S. Strength

BAE, led by CEO Ian King, was the U.S. government’s ninth-largest contractor in fiscal 2011, with $7.3 billion in direct,
or prime, contracts, while EADS was its 100th, with $684 million
in contracts, according to a Bloomberg Government study ranking
the top 200 contractors.

The two companies employ about 45,000 workers in the U.S.,
90 percent of them at BAE, and operate under special security
agreements with the government. BAE supplies the U.S. military
with combat vehicles and artillery such as the Bradley fighting
vehicle, the self-propelled Paladin howitzer and naval guns.

EADS makes UH-72 Lakota light-utility helicopters for the
U.S. Army. The company in 2011 lost a bid to Boeing to develop a
new refueling tanker for the Air Force as part of an estimated
$35 billion program.

Given the “highly secure and sensitive” nature of the
defense business involved, BAE and EADS plan to ring-fence
certain activities, particularly relating to the U.S., the
world’s biggest defense market, they said.

U.K. Shortfall

Weapons makers worldwide have been struggling with
shrinking defense budgets as austerity-minded administrations
rein in spending. BAE has suffered as Britain seeks to eliminate
a 38 billion-pound defense shortfall, while governments across
Europe have cut commitments for Eurofighter combat jets and
armored-vehicle sales have fallen following the end of the war
in Iraq and a wind-down of troop numbers in Afghanistan.

Governments in Germany, France and the U.K. would be issued
with special shares in the new business, BAE said. EADS has also
agreed to pay shareholders 200 million pounds before completion
to help harmonize the companies’ dividend payouts.

Among EADS’s biggest shareholders is the French government,
which owns 15 percent. German carmaker Daimler AG controls 22.5
percent, of which 7.5 percent is owned by German federal states
and some banks. The Spanish government owns 5.4 percent. Daimler
said it still intends to reduce its stake in EADS this year.

European Schism

The British government’s Department of Business, Innovation
and Skills said it was aware of the merger proposal and that
while any business benefits are “a matter for the companies,”
it will ensure that the public interest is protected in any
deal.

BAE was created in 1999 when British Aerospace Plc, which
had been exploring a merger with Daimler’s Dasa unit in Germany,
opted instead for an all-U.K. combination with the Marconi
Electronic Systems unit of GEC in 1999.

That prompted Dasa first to acquire Construcciones
Aeronauticas SA of Spain and then to combine with France’s
Aerospatiale Matra SA to form EADS. The sequence of events gave
EADS control of 80 percent of airliner manufacturer Airbus,
which BAE exited in 2006, while allowing the U.K. company to
dominate the European defense sector.

Morgan Stanley, Goldman Sachs Group Inc. and Gleacher
Shacklock LLP are advising BAE, with Freshfields Bruckhaus
Deringer LP as legal counsel. UBS AG is serving as BAE’s
corporate broker on the deal. EADS is being advised by Evercore
Partners Inc., Perella Weinberg Partners LP, Lazard Ltd. and BNP
Paribas SA, and Clifford Chance LLP is acting as counsel,
according to two people familiar with the matter.

Credit Suisse Group AG will probably be asked to compile a
fairness opinion, said one of the people, who asked to remain
anonymous because the advisers have not been publicly announced.